BIM35625 - Capital/revenue divide: intangible assets: surrender of onerous lease

Does the trade comprise or include dealing in leases?

Where the taxpayer’s trade does not comprise or include buying and selling leases, a lease is a fixed capital asset. The costs of acquiring or disposing of the lease are therefore on capital account. This will remain the case even when the disposal is for sound business reasons including cases where it is uneconomic to retain the lease.

In the case of Mallett v The Staveley Coal and Iron Company Ltd [1928] 13TC772 a colliery company made two payments to be released from the remaining term of two mining leases. Whilst the leases endured the company was required to get coal despite that being uneconomic. The company claimed that the payments to be released from the onerous leases should be allowed because:

1. they secured no asset or advantage, and
2. they represented the commutation of an annual charge which otherwise would have had to be met.

The courts denied relief on the following grounds:

1. the company’s business was not and did not include dealing in mining leases,
2. the leases were fixed capital assets of the company’s business, and
3. the expense of acquiring or disposing of a capital asset was itself capital.

Rowlatt J explains why, notwithstanding that the company did not acquire any assets, the payments were on capital account; saying at page 778:

They have got nothing, says Mr Latter (counsel for the company), for this expenditure. Well, perhaps they have not, but there is this, that they have now got a list of leases or a field of mineral which has the advantage of being minus an undesirable part of it, instead of having one that is encumbered with an undesirable part of it…It seems to me that the whole transaction, on the clearest possible principles, is a capital transaction. But now it is put another way. The cases were referred to where payments have been made, principally to servants or members of the staff,…redeeming an annual business expenditure by a payment in one particular year instead of over a number of years, and where that is done the payments can be deducted…Here that entirely breaks down. It is not the case at all. The company do not make these payments to get rid of any annual charge against revenue in the future. They make these payments to get rid of the loss in the business or apprehended loss in the business…They are paying this money in other words in order pro tanto to go out of business. They are not meeting in advance an annual demand in the business.

In the case of Cowcher v Richard Mills and Company Ltd [1927] 13TC216 the company decided to close an unprofitable branch and to give up the lease on the premises. The company paid the landlord a sum by annual instalments. After paying some instalments the company settled its liability for an agreed lump sum. The courts decided that the payment was capital, being the cost of getting rid of an onerous capital asset - the lease. The company did not deal in leases. In the company’s hands the lease was a fixed capital asset. The cost (direct and incidental) of acquiring or disposing of fixed capital assets is capital expenditure and not deductible in computing profits.

The Special Commissioners decided in the case of Bullrun v CIR [2000] SPC 248 that a payment made to surrender an onerous lease was capital. Bullrun was incorporated in the United States and was owned by a partnership of designers. Bullrun leased premises in London for 10 years. The annual rent was £550,000 for five years after which it could be reviewed upwards. After some four years the rent payable under the lease exceeded the market rent and Bullrun wished to surrender the lease. Bullrun entered into an agreement with the landlord to surrender the lease and pay the landlord £550,000, by quarterly payments of £25,000. Bullrun charged the full £550,000 to its profit and loss account as an exceptional item including in creditors the amounts to be paid later. Accountancy evidence was given and accepted that this was the only possible treatment consistent with GAAP, specifically with SSAP2 (see BIM31030).

Bullrun claimed to deduct the £550,000 arguing:

1. the lease was not a capital asset,
2. the lease was not the whole structure of the profit making apparatus,
3. the surrender merely effected a change in the business organisation leaving the capital untouched,
4. that a lump sum payment made to extinguish recurring revenue payments was prime facie a revenue payment.

The Revenue argued that the lease was a capital asset and a payment made to surrender a capital asset is capital.

The Special Commissioner reviewed the tax cases referred to in argument and summarised the principles that could be derived from them:

1. By entering into the lease Bullrun acquired an advantage of enduring benefit for the trade - Atherton v British Insulated & Helsby Cables Ltd [1925] 10TC155 (see BIM35010). It did not matter that no premium had been paid to acquire the lease.
2. The question is whether the payment is an expense of earning money in the business that is carried on and the treatment in the accounts is indecisive - Cowcher v Richard Mills and Company Ltd [1927] 13TC216 (see above).
3. A lease is a capital asset of the business notwithstanding that no premium was paid to acquire it - Mallett v The Staveley Coal & Iron Co Ltd [1928] 13TC772 (see above).
4. There is a distinction between a lease which is a capital asset and a commercial contract which is not a capital asset - Anglo-Persian Oil Company Ltd v Dale [1931] 16TC253 (see BIM35505) unless the commercial contract is such that its ending will destroy the whole structure of the profit making apparatus - Van den Berghs Ltd v Clark [1935] 19TC390 (see BIM35530).
5. Where the trade is not the buying and selling of leases premiums paid for leases are always of a capital nature being the price of acquiring an interest in land. There is no distinction between a lease at rent and a premium and a lease at a rack rent - Strick v Regent Oil Co Ltd [1965] 43TC1 (see BIM35560).
6. Interests in land are capital assets and payments made to enhance land are on capital account - ECC Quarries Ltd v Watkis [1975] 51TC153 (see BIM35325).
7. A lease is still a capital asset even when it is non-assignable and has no balance sheet value - Tucker v Granada Motorway Services Ltd [1979] 53TC92 (see BIM35320).
8. A lease of land on which a trader conducts his business is a capital asset - RTZ Oil & Gas Ltd v Elliss [1987] 61TC132 (see BIM35420).
9. Expenditure to acquire an interest in land on which a business is carried on is capital - Rolfe v Wimpey Waste Management Ltd 62TC399 (see BIM35605).
10. The decision in Vodafone Cellular Ltd & Others v Shaw [1997] 69TC376 (see BIM35585) (that a payment to get rid of an onerous commercial agreement, which was not the whole structure of the profit making apparatus, was revenue) does not disturb the rule that payments made to get rid of leases and commercial contracts that do relate to the whole structure of the profit making apparatus are capital.
11. A lump sum payment to enter into an onerous lease above market rent is capital - Commissioner of Inland Revenue v Wattie and Lawrence [1978] 72TC639 (see BIM35610).

Bullrun’s business was that of designer and not the buying and selling of leases. Bullrun did not make the surrender payment for the purpose of the provision of design services and so it did not count as a proper deduction against its trade income.